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To avoid investing in a business that's in decline, there's a few financial metrics that can provide early indications of aging. Typically, we'll see the trend of both return on capital employed (ROCE) declining and this usually coincides with a decreasing amount of capital employed. This combination can tell you that not only is the company investing less, it's earning less on what it does invest. Having said that, after a brief look, Summit Midstream (NYSE:SMC) we aren't filled with optimism, but let's investigate further.
Return On Capital Employed (ROCE): What Is It?
Just to clarify if you're unsure, ROCE is a metric for evaluating how much pre-tax income (in percentage terms) a company earns on the capital invested in its business. The formula for this calculation on Summit Midstream is:
Return on Capital Employed = Earnings Before Interest and Tax (EBIT) ÷ (Total Assets - Current Liabilities)
0.039 = US$84m ÷ (US$2.3b - US$160m) (Based on the trailing twelve months to March 2024).
Thus, Summit Midstream has an ROCE of 3.9%. Ultimately, that's a low return and it under-performs the Oil and Gas industry average of 12%.
View our latest analysis for Summit Midstream
Above you can see how the current ROCE for Summit Midstream compares to its prior returns on capital, but there's only so much you can tell from the past. If you'd like, you can check out the forecasts from the analysts covering Summit Midstream for free.
The Trend Of ROCE
The trend of returns that Summit Midstream is generating are raising some concerns. The company used to generate 5.2% on its capital five years ago but it has since fallen noticeably. What's equally concerning is that the amount of capital deployed in the business has shrunk by 20% over that same period. When you see both ROCE and capital employed diminishing, it can often be a sign of a mature and shrinking business that might be in structural decline. Typically businesses that exhibit these characteristics aren't the ones that tend to multiply over the long term, because statistically speaking, they've already gone through the growth phase of their life cycle.
What We Can Learn From Summit Midstream's ROCE
In summary, it's unfortunate that Summit Midstream is shrinking its capital base and also generating lower returns. Long term shareholders who've owned the stock over the last five years have experienced a 51% depreciation in their investment, so it appears the market might not like these trends either. That being the case, unless the underlying trends revert to a more positive trajectory, we'd consider looking elsewhere.